Your Investment Strategies Making You Nervous? Abort!

Yesterday’s post about the down market stirred up a lot of angry comments because I encouraged the person to get out of stocks if they are scared. There was perhaps some justification to it because I interpreted the person who sent in the question to be very nervous when she may have in fact not been. Here’s the truth, though: if that person was as scared as I understood her to be, she should have never been in stocks in the first place.

If you are investing in stocks right now and you’ve been up late at night the last several nights reading stock news and sweating about what your 401(k) is doing, my perspective is that your portfolio should be more conservative. Decrease the portion of your portfolio that’s in stocks and increase the amount that’s in other assets (money markets, bonds, etc.). They might not return as well as stocks when the bulls are running, but they will always return in the positive.

Many of the negative comments were from people whose risk tolerance is high enough that they feel just fine through this bumpy ride. That’s fine for them – they have a high risk tolerance and if they’re happy with their investments, they should stay where they’re at. I completely understand the logic behind riding out this market and continuing with regular investments – things like dollar-cost averaging can potentially pay off big here.

Where do I personally sit? Generally, I stay in stocks and buy when the market burps when I understand the fundamental reason why that burp occurs. I don’t understand this one very well at all – it seems to me to be based on a fallacy that people with $30K incomes can repay $500K adjustable rate mortgages. When I run the numbers on that, it doesn’t seem reasonable or even possible, and with so many of these mortgages out there, someone’s going to have to eat some major losses when those houses go into foreclosure and suddenly those mortgages aren’t worth much at all. Who’s going to pay? Honestly, I don’t know how deep that rabbit hole goes (and neither does anyone else), so I’m not buying back into stocks for a while (I got out of stocks in my non-retirement accounts in June to pay for my own house). Volatility doesn’t bother me unless the volatility is being triggered by mass stupidity, which is why the markets make me nervous right now but other burps don’t.

However, if you simply can’t tolerate the volatility, my belief is that you should not be invested heavily in stocks.

What else should I do with my money? Focus primarily on paying off debts above all else – it’s never a bad time to eliminate personal debt. Invest in bonds or money markets, for starters – nice, stable investments that don’t see nearly as much volatility as stocks.

What about new investors? The best thing a new investor can do is get educated by reading a lot of books on investing, not just in stocks. Pick up books like The Bogleheads’ Guide to Investing, for starters, and watch what different investments do over time. Don’t feel bad if you get into an investment and then find that the volatility scares you. Just back out and invest elsewhere, somewhere more conservative.

What if I need the gains of stocks in my portfolio? You need to decide for yourself how badly you “need” a 10% return versus a 6% one. Is it worth lots of sleepless nights and anxiety, which aren’t good for your health? From my perspective, any investment that keeps you up at night should not be a part of your portfolio. If you need that 10% return, how about looking at your own life for some frugal choices so that you can invest more at 6% so you have that save dollar value at the end of the year? That way, you can sleep better at night and still have that dollar in your pocket.

I don’t know where you can get 6% after tax and inflation? If you do then sure you can forgo investing in the stockmarket, but as I commented on the original post most individuals need the gains only the stock market can give (vs. fixed income) to have enough for retirement. Not to say there aren’t other investments including real estate that can generate great returns but potentially involve more work and risk. Not investing in the stock market is like trading for sleepless nights in the future. Obviosuly if your income is such that you can afford to save and only need mediocre returns of 1% after tax and inflation (which is what it would be in many of these “safe” investments”) then that’s another story.

If you feel the housing market is going to crash, I would think that you would be at least as concerned with your having just bought a house.

I’m not saying it was a bad move — I recently purchased a home too. BUT, I have been told by others that they think it was not a smart time to buy because of this possibility of a downturn in the market.

If you apply the same rule as you did for stocks, then now would be a good time to sell your house.

I obviously don’t think you should do this, but your advice might lead someone to that conclusion. I certainly would be kept up at night if I thought my biggest investment was about to have a huge drop in value.

I went back and re-read all of the comments in the other post. One commenter called you a name. That’s the only one I could find that could be classified in as “angry” (although I actually agreed with the sentiment). The other comments either asked for clarification of your advice or stated the commenter’s disagreement with your advice. No anger, no insults, just “I believe that is bad advice.”

You’ve clarified a lot with this post. I think some of the confusion stemmed from the title of the other post (“Basic investing in a down market”). A reader who was looking for advice on the stated topic didn’t actually find it – what we found would have been better titled “Investing for people with low risk tolerance” or “Does the market scare you, too? Here’s what I did.” You didn’t deliver on your chosen title.

IF you are unable to sleep at night, its because you don’t appreciate what has happened in the market over the last 10 years. Here is a link to yahoo comparing the Vanguard Total Bond Market Index to the dow since aug ’97. Sure the dow went up, crashed (’02), came back and is now down ~8% in the last month (still positive for the year, as in not losing any money since 1/1/07). The bond fund is down for the year.

I agree with Matt. I also think you’re oversensitive about the responses you receive. Oftentimes blogs like these would not be nearly as interesting without the great comments and that includes the devil’s advocates.

This post does do much to clarify. I think better advice than “get out if your investments’ volatility scares you” would be an admonition that you need to know why you’re investing before you start investing. If you don’t know, park it in savings accounts. If you decide you want a house in, say, 10 years, or to retire in 30 years, allocate assets accordingly and feel confident that you’ve made a good choice.

I love your writing syle but I have to say I disagree with your advice on selling your stock holdings in a down market. I worked in the mutual fund industry for many years and here is why many investors don’t make money. They panic when the market goes down and the move to cash and bonds. The market recovers after 6 months or 2 years. These same investors are now getting interested in investing in stocks again. They get back into the market when it up past when they got out. Repeat. The problem is no one can predict when to sell and when to buy again. I love your prediction on the economy, the only problem again is NO ONE KNOWS WHAT THE ECONOMY IS GOING TO DO. Ask different economists and you will get different answers. I have been investing for over 20 years and buying when everyone else is selling is the best way to make big gains. Stick with your how to save money tips!

If, as you say, she should never have been in stocks in the first place, why would you advise getting out of the market and waiting three weeks before deciding whether or not to go back in?

I agree that people shouldn’t invest in things that make them nervous. However, whether you intended this or not, your previous post came across as advocating getting in and out of the market depending on your comfort level. As others have pointed out, this is a recipe for locking in losses and minimizing gains.

The main reason people shouldn’t invest in stocks if it makes them uncomfortable is because their discomfort is likely to cause them to sell low and buy high, so they will not actually get the good returns one hears about with the market. Those folks will thus be able to get much better returns in “safer” investments. They should either never buy stocks or train themselves to buy and hold.

And the problem with riding out these plummets is that you never really know if the plummeting is just cyclical or if something is really ruined. This has actually been my most worry-free stock drop since I’ve started investing because I think it’s just lenders and real-estate investors and related bond investors who will be affected and I don’t think any of those people are me. (Yes, I may be in la-la land; I’m just explaining why I’m not worried.)

Before this, it was because gas prices were going through the roof which will eventually affect the prices of everything and which will be permanent because unlike in the 1970s, the price rise is not due to OPEC wielding their powers but to actual shortages that will only get worse. Forever.

During the fall of Enron, it seemed like everything we know about publicly traded companies could be a sham and that they all are really in much worse shape than they look like and the whole stock market is just a house of cards.

Then there was the one where terrorists killed thousands and would have killed more if we hadn’t grounded all aircraft (unheard of!) and who knew how many more attacks there were going to be? Our entire society (including the economy) might be about to be ruined forever, just like the fall of the Roman empire.

Before that everyone knew there was a stock market bubble. They knew this already in 1995. When things started plummeting in 1999, who knew how far it would fall with people going too far in the opposite direction?

My point is that a lot of these so-called corrections are quite scary and do not seem like corrections while they are happening. So it’s not enough to be able to ride out corrections. You also have to be able to ride out potential disasters. And let’s face it, riding out the Great Depression was not the wisest move of all time. I think it took fifteen years just to get back to the peak of 1929, so disasters really do happen.

I handle price plummets by staying diversified and by trying to choose good companies rather than just profitable-looking ones. (One strategy for doing this as an ignoramus, which I mostly am, is having an S&P 500 index fund. As soon as a company goes downhill far enough, it falls off the S&P 500 and gets replaced by a growing company.)

My other strategy is to put only long-term money in the market. If I don’t need the money yet, it doesn’t matter how much I have right now; it only matters how much I’ll have when I need it. This is what I tell myself anyway. And I tell myself things like, “Hey, I am so rich that I am the type of person who can lose $1000 in only one week. Awesome!”

I’m not comfortable with giving people advice based on their “comfort level.” If someone came to me and said that she was deathly afraid of flying on airplanes, I would ask her why she was afraid of flying, give her statistics on driving vs. flying, try to address as many of her fears as possible, and then ask her if she still thought her fears were reasonable. In other words, I would try to turn the discussion from a fear-based one to a fact-based one. Now, there are good reasons to believe that the stock market is headed for a long-term slump (Trent lists one), and there are good reasons to believe that it won’t. The key is knowing your reasons and deciding calmly to either tolerate the risk or not. It should be a reasoned decision and not one derived from whether one has trouble sleeping or has a funny feeling in the gut.

I haven’t read all of the comments in the previous thread, but the quoted poster didn’t sound that scared.
IMHO, there are various degree of nervousness. I would imagine many a first time investors worry during the first big market drop. I am old enough to remember 1987 crash. It was only 4 years after I started working and I only had a little of my employer stock back then – all bought via the company’s stock purchase plan. I stayed up all night watching how the value of my holdings was dropping as the selling continued in Europe. I only lost about $5000, but it was a big deal for me back then. I resisted selling immeditely thereafter, and I am glad of it. I wish I bought more stocks in 1987, but I was too much of a chicken. At other times, I sold stocks when I was nervous, including keeping too much of my 401K into fixed income funds, moving out of stock at the wrong moments and missing out on some big jumps. So acting out of fear is not the best course of action.

On the other hand, somebody who is jumping from joy when a specific stock goes up 1 point only to loose sleep when it dropped 1 point probably shouldn’t be in the market. But selling every time there is panic is probably not a great idea either. I do think that it is important to haven enough money outside the stock market for emergencies.

I don’t really see a big problem in one’s primary home loosing value unless one needs to sell or refinance or the drop seriously affects the neighborhood. If you plan to live there long term and if you like your place than why worry? I do think the housing prices may go down more — I just don’t see how young people can afford to buy now (at least not here in Northeast) when the prices are so inflated because people bought places they couldn’t afford. Not that I know much.

Thanks for the clarifications. I thought both posts were interesting. There is a psychological risk in what you originally suggest in that people get scared together and get excited together. If you get caught up in the fear or the excitement, it seems like it’s pretty easy to end up buying high and selling low. I just finally got my meager $500 IRA rolled into an account I can control, and I’m looking forward to seeing what happens with it.

I htink your basic advice about not investing outside of your comfort zone is good advice though. Maybe your commenter invested in stocks when everyone thought they were great, and now wants to sell when everyone thinks things are bad. This is the worst case.

“Any investment that keeps you up at night should not be a part of your portfolio”

I had issues with your previous sentiment, but not to this one. Life’s too short to worry about this, not to mention that if you’re worried, it means you are uncertain of the outcome, which means you’re gambling. Which is fine for entertainment, not so much for your retirement. :)

Reminds me of a Warren Buffet quote. Where is it, now…

Ah, yes. When asked about his reluctance to invest in tech during the bubble, he said:

“That’s not to knock Microsoft. If I had to bet on anyone, I’d bet on Microsoft. But I don’t have to bet.”

I really appreciate this post, Trent. It’s very true that people with risk tolerance shouldn’t be investing in the stock market. I certainly hope my previous post wasn’t taken as anger.

The article I referenced in Money is about how we’re biologically still cavedwellers with cavedweller brains. We react the same way to market crashes as we do to bear attacks: panic first, think later. It’s just how we’re wired, even if we can drive nice cars and live in air-conditioned houses.

That’s why I disagreed with the way your initial advice was phrased: I felt you were advocating a fear response. We should determine our risk tolerance, invest, and then stick to that strategy. I see that’s what you’re advocating here and totally agree!

Lately the market has been testing the mettle of every investor. I am disappointed by the number of pf-bloggers who, after channeling John Bogle (DCA, buy-and-hold, index funds over stocks) when times were good are now running for the hills.

Trent, I’m disappointed by your advice. This is the exact moment that people need to “hold on tight” and keep DCA-ing and not pull out of the market. Anyone who takes the long-term view could see that. Now is the time to “practice what you preach”. Keep DCA-ing, hold-your-positions, don’t watch the markets daily.

Instead, I see many pf-bloggers (who I, at one time, respected) suggesting people should listen to their fear and doubt and pull their money out now. BFP has even pulled their investment out while making (lame) rationalizations. (BTW, FCN gets kudos from me for sticking to his guns.)

Finally, Trent, don’t get me wrong, I enjoy your site. But, frankly, between this post, the Stock Options “advice”, and the “investing a 50 million dollar trust” post, you have to admit that your investment advice over the past few weeks has been less than stellar. I understand that you’re “just a guy” and your advice should not be taken as gospel, but consider that some of your readers will attribute some expertise to your advice as opposed to, let’s say, their neighbor.

Trent, your best advice by far was to pay down debt. Nothing like a little worry about your fiscal future to realize debts are not going to help you get there!

I just wanted to point out a quote at BusinessWeek today from the revered John Bogle:

“Even if I was pretty confident that the decline will continue—and I think it’s more likely than not—you’ve not only got to get out right, you’ve also got to get in right. You must be right twice. So if you get out now, and the market goes way down another 15 or 20%, which is quite possible, they will be so scared they won’t get in.”

I’ve seen many people the last few weeks freak out about the stock market who don’t normally pay attention, mostly because its swings have hit the mainstream media. !wanda! above had it right. 1.Pay down debt 2.breathe 3.educate yourself to have a good plan. 4.reallocate if need be (like you suggested, if you just aren’t comfortable).

If you enter and exit the market because you “feel” good or bad about it, then you are a fool. Period. And a fool and his money are soon parted, as the saying goes…

Ever heard of “loss aversion”? It’s the psychological theory that humans are much more averse to suffering a loss then they are to acquiring a gain. It’s a fascinating behavior and it is absolutely at work here. The market correct 10% and people are getting all panicky.

buying a house when the market’s about to crash is only a bad idea when you intend to sell your home for a profit. Otherwise, you just live in it for the rest of your life and maybe your grandkids will profit from it.

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Every time I see anything on the news about credit-nation, housing bubble, inflation… I turn to my wife and say “That’s why I’m very comfortable that we just used that money to pay off all our c/c’s”.

I totally agree that now is a great time to have zero personal debt – certainly zero CONSUMER personal debt (ie, c/c). Every time there’s talk of a rate rise (they just put our mortgage by $30/mnth last week) I’m not terribly upset, because if that’s the worst that’s going to happen to us through all this then we’re sitting pretty.

@Toby: Yeah, I’ve heard of loss aversion, and that’s exactly the point. If someone’s personal loss aversion doesn’t match up with the risk component of their portfolio, then sooner or later bad market conditions (like now) will put them into a buy-high/sell-low panic. Comfort-level investing, and there’s probably a better term for it, means investing so that levels of acceptable risk and actual risk match. Potentially smaller gains due to lower risk levels, but much less likelihood of dropping those gains in a panic. You lumped Trent in with other bloggers in freak-out mode, but IMO his advice to whoever is consistent with the views he’s expressed on risk aversion all along.

Personally I have around 40 years until retirement, so my only question the past week has been what to buy.

It’s unwise to say things like “they will always return in the positive”, even with your disclaimer in the page footer. It’s a lawsuit waiting to happen, especially with conservative investments like paper in danger right now.

I have been reading your blog for awhile, enjoy it, and have learned a lot from it. I agree your investment advice is something you need to improve and I think it’s because you read too many mass-market PF books. Still, you write a good mix of content and I am glad you post as often as you do.

I have always advocated comfort-level investing. Most readers seem to lump me in with what they’ve read elsewhere – not sure why that is. Stock investing is much like riding a roller coaster – if you ride the coaster, get off at the end, throw up, and are miserable for the rest of the day, don’t ride the roller coaster.

Most of the people criticizing my advice are coming from a different philosophy and a different risk tolerance. That’s fine, but I don’t criticize their philosophy and I think it’s pretty cheesy to come in and slam mine. It’s a difference in philosophy, period.

1. In reference to money markets and bonds, you said “but they will always return in the positive.” Not true. Bonds lose money due to credit and interest rate risk, among other things, although they are not as volatile as equities.

2. The investor’s greatest risk to their portfolio is often the investor. We buy into a rising market and, out of fear, sell into a declining market. Check out any fund on Morningstar, click Total Returns and then Investor Returns. Investor returns shows what investors as a whole actually made based on money flowing into and out of the fund. Many, many funds show investor’s actual returns as less than the funds returns because they buy high and sell low.

Living through down markets without selling is no fun, but it is the only way to achieve some level of success as an investor.

Trent: I understand what you are saying. You advocate investing based on risk tolerance. The problem is that most people’s risk tolerance goes up when the market does and plummets when the market moves down. I’m at odds with your advice because for the reader asking the question, the stock market was just fine to invest in a month ago. Now, suddenly, they are “risk-averse” and you seem to be confirming their fears instead of pointing out that this is the classic “bad-move” (selling low) for any investor to make.

To quote Blaise Pascal via Warren Buffett:

“All human evil comes from a single cause, man’s inability to sit still in a room.”

@disavow: I think you are slightly confused on what “loss aversion” actually is. Without getting into too much technical detail, it is a trick one’s brain plays on them that causes that person to want to avoid loss. It manifests when things like market downturns occur and people flock to the exits. It is something that one should identify and control lest it cause one to make rash decisions.

What you are getting at is risk tolerance. That is something that everyone must understand and use for the basis of their investing. However, if one decides that the stock market is within their “risk-tolerance” and puts their money in and then later gets nervous during a downturn, they should ask themselves if they truly mis-interpreted their risk-tolerance, or, if it is more likely that they are just suffering some “loss aversion” and need to sit on their hands for a little while?

Good point Toby, although I think Trent was saying if you’re like that you shouldn’t invest at all.

I guess I agree with Trent with the caveat that philosophies can change through education. If someone is scared of losing in the stock market, maybe there are a few things you can say to make them feel more secure, but in advising total strangers I can see how that would be way more responsibility than one may want to take on. I wouldn’t do it, but I also wouldn’t encourage their philosophy. I guess I’m somewhat of a coward :)

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